MANAGEMENT REPORT ON FINANCIAL OPERATIONS
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity
through effective and efficient regulation. NASD touches virtually every aspect of the securities business—from registering all
industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering
the largest dispute resolution forum for investors and firms.
The following discussion and analysis of financial condition and results of operations should be read in connection with the
consolidated financial statements and notes thereto included elsewhere in this Annual Financial Report. The 2004 consolidated
financial statements reflect the combined activity of NASD and its consolidated subsidiaries, The Nasdaq Stock Market, Inc.
(NASDAQ); NASD Regulation, Inc. (NASDR); NASD Dispute Resolution, Inc. (NASD DR); NASD Investor Education Foundation (NIEF);
and New NASD Holding, Inc. (NASD Holding), which held NASD’s Class B interest in The American Stock Exchange LLC (Amex). On
December 31, 2004, NASD completed the sale of its Class B ownership interest in Amex to the Amex Membership Corporation.
Amex results have been reported as a discontinued operation in the consolidated financial statements. (References to NASD and its
consolidated subsidiaries throughout are collectively referred to as “the Company.”)
The Company views its business as consisting of two segments as defined by Statement of Financial Accounting Standards (SFAS)
No. 131, “Disclosures About Segments of an Enterprise and Related Information.” These segments, NASD and NASDAQ, are
managed and operated as separate, stand-alone companies, each with its own corporate governance. NASD consists of regulatory
operations, and is a self-regulatory organization (SRO). NASDAQ consists of the operations of The NASDAQ Stock Market.
While this report reflects the consolidated operations of the Company, the primary focus is on the NASD segment, including
NASDR and NASD DR. This focus is consistent with the steps the Company has taken to divest itself of ownership and operation of
securities markets and is intended to highlight discussion of areas that will remain with NASD upon completion of the NASDAQ
For the year ended December 31, 2004, the Company’s consolidated net income was $66.5 million compared with a net loss of
$57.7 million in 2003. Included in the 2004 results is a cumulative effect of a change in accounting principle of $58.3 million and
income from discontinued operations of $19.7 million. Income from continuing operations was $105.1 million in 2004 compared
with $50.0 million in 2003.
2 NASD 2004 ANNUAL FINANCIAL REPORT
2004 marked another successful year for NASD in its goal to solidify its leadership position as the preeminent U.S. private sector
regulator in the financial services industry. NASD completed the sale of Amex to the Amex Membership Corporation, further
separating itself from ownership and operation of stock exchanges. NASD and NASDAQ made significant strides toward further
reducing NASD’s ownership of NASDAQ common stock and worked closely on other steps to better position both organizations
for operation once the Securities and Exchange Commission (SEC) approves NASDAQ’s Exchange Registration. In February 2005,
NASDAQ completed an underwritten secondary offering including 16.6 million shares of common stock previously owned by
NASD. As a result of this transaction, NASD’s economic ownership interest in NASDAQ has been reduced to 33.7 percent.
2004 highlights for NASD in fulfilling its mission of investor protection and market integrity:
• Filed 1,396 enforcement actions, barring or suspending 833 individuals, and levying and collecting more than $103.9
million in disciplinary fines.
• Dramatically increased transparency in the corporate debt market through the dissemination of transaction information
on corporate bonds reported through NASD’s Trade Reporting and Compliance Engine (TRACE) to 22,000 bonds, or
more than 98 percent of the investment grade market. NASD brought full transparency to the corporate bond market in
February of 2005.
• Dispute Resolution closed the year with 8,201 claims filed in arbitration and 1,217 mediation cases in agreement. The
forum also closed 9,209 cases, an all-time record. NASD opened seven new hearing locations across the United States. By
March 2005, Dispute Resolution had established at least one hearing location in each of the 50 states.
• Funded the newly created NIEF with an initial endowment of $10.0 million in March of 2004. NIEF will provide grants for
educational programs and materials for the investing public.
• NASD, together with the SEC, settled a major mutual fund sales practice case against First Command Financial Planning,
Inc. (First Command), a Texas-based firm that specialized in selling expensive systematic investment plans to military
personnel. First Command paid a $12.0 million fine, and NASD directed its portion of the fine to be paid directly to the
NIEF to support educational programs, materials, and research to help equip members of the military community with the
knowledge and skills necessary to make informed investment decisions.
• In the area of rule writing, NASD moved forward with a number of important investor-focused proposals that touched on
nearly every aspect of the securities industry, including variable annuity suitability and other recommendation
requirements; requirements for securities firms to establish emergency preparedness plans; and new rules to ensure that
firms effectively monitor the activities of their employees, especially those who manage office locations and also conduct
their own securities business. NASD also put in place a required annual certification by chief executive officers of securities
firms that the firm has processes to establish, maintain, review, test, and modify written compliance policies and written
NASD 2 004 ANNUAL FINANCIAL REPORT 3
RESULTS OF OPERATIONS
The following table sets forth consolidated revenues by segment and revenue category:
NASD CONSOLIDATED NET REVENUES BY SEGMENT
YEARS ENDED DECEMBER 31,
NASD NASDAQ Consolidating Consolidated NASD NASDAQ Consolidating Consolidated
Market services $ – $ 334.5 $ (2.0) $ 332.5 $ – $ 383.7 $ (0.1) $ 383.6
Issuer services – 205.8 (4.3) 201.5 – 204.2 – 204.2
Regulatory fees 222.8 – – 222.8 174.2 – – 174.2
User fees 137.3 – – 137.3 128.4 – – 128.4
Transparency services 14.7 – – 14.7 21.1 – – 21.1
Contract service fees 58.1 – (53.4) 4.7 63.1 – (60.5) 2.6
Dispute resolution fees 80.2 – – 80.2 75.5 – – 75.5
Other fees 8.9 0.1 (6.7) 2.3 9.7 1.9 (7.0) 4.6
Total operating revenues 522.0 540.4 (66.4) 996.0 472.0 589.8 (67.6) 994.2
Activity assessment 230.9 – – 230.9 365.8 – – 365.8
Fines 114.4 – – 114.4 33.3 – – 33.3
Total revenues 867.3 540.4 (66.4) 1,341.3 871.1 589.8 (67.6) 1,393.3
Cost of revenues (230.9) (55.8) – (286.7) (365.8) – – (365.8)
Net revenue $ 636.4 $ 484.6 $ (66.4) $ 1,054.6 $ 505.3 $ 589.8 $ (67.6) $ 1,027.5
NASD net revenues were $636.4 million in 2004 compared with $505.3 million in 2003, an increase of $131.1 million or 25.9
REGULATORY FEES include the transaction-based trading activity fee, as well as assessments based on member firm gross income
and number of personnel. Regulatory fees totaled $222.8 million in 2004 compared with $174.2 million in 2003, an increase of
$48.6 million or 27.9 percent. Regulatory fees are used to fund NASD’s member regulatory activities, including the regulation of
members through examinations, processing of membership applications, financial monitoring, policymaking, rulemaking, and
enforcement activities. To ensure adequate funding levels for member regulatory programs, the rates charged for trading activity
fee services were increased in September of 2003. Based on the increased rate structure and higher trading volumes in 2004,
trading activity fees totaled $110.0 million in 2004 as compared with $70.9 million in 2003. Further contributing to the increase in
regulatory fees were personnel assessments, which totaled $33.3 million in 2004 as compared with $20.5 million in 2003. The
increase in personnel assessments between years was driven by a planned three-year phase-in approved by the SEC in 2002. In
November 2004, the trading activity fee rates were also reduced as part of this three-year phase in of regulatory fee pricing
changes. These revenue changes have been instituted to better align NASD’s regulatory fees with its functions, efforts, and costs.
4 NASD 2004 ANNUAL FINANCIAL REPORT
USER FEES include fees charged for initial and annual registrations, qualifications exams, fees associated with NASD sponsored
meetings and conferences, and charges associated with the review of underwriting arrangements in corporate filings. User fees
totaled $137.3 million in 2004 compared with $128.4 million in 2003, an increase of $8.9 million or 6.9 percent. This increase was
primarily attributable to an increase in the number of corporate filings and increase in the average size of filings reviewed. As a
result, corporate financing revenues increased $5.9 million or 58.1 percent over 2003 levels. Further contributing to higher user fee
revenues were an increase in the number of advertising filings reviewed and an increase in the number of conferences held by
NASD’s education and training area. In 2004, in connection with the implementation of Emerging Issues Task Force (EITF)
No. 00-21, “Revenue Arrangements with Multiple Deliverables,” NASD has separated first year registration fees into their initial
and annual components and has begun to defer and amortize the initial fee component over an estimated customer relationship
period. See the Cumulative Effect of a Change in Accounting Principle section for further discussion.
TRANSPARENCY SERVICES represent fees charged for services offered through TRACE and NASD’s Alternative Display Facility
(ADF). Transparency services revenues were $14.7 million in 2004 compared with $21.1 million in 2003, a decrease of $6.4 million
or 30.3 percent. This decrease was due to the loss of ADF’s largest customer in February of 2004, which led to a decline in ADF
market data fees from $7.8 million in 2003 to $1.7 million in 2004. TRACE, which began operation in 2002, represents fees
charged on secondary market transactions in eligible fixed income securities reported to NASD, as well as TRACE system related
fees, and TRACE market data fees. While TRACE average daily volumes were down slightly in 2004, the number of terminals
receiving corporate debt information increased, yielding consistent revenue performance for TRACE between years.
CONTRACT SERVICES FEES represent amounts charged for regulatory services provided primarily to NASDAQ and Amex, as well as
other exchanges such as the International Stock Exchange and the Chicago Climate Exchange, associated with surveillance,
monitoring, legal, and enforcement activities. Contract services fees totaled $58.1 million in 2004 compared with $63.1 million in
2003, a decrease of $5.0 million or 7.9 percent. This decrease was driven by lower depreciation charges and lower spending on
NASDAQ initiatives, as well as a reduction in fees charged to NASDAQ due to a shift in the allocation of regulation resources
between market and member regulation. Overall NASDAQ contract service fees declined from $61.8 million in 2003 to $45.6
million in 2004. Offsetting declines in NASDAQ contract service fees were new billings under the Amex Regulatory Services (RSA)
agreement, which took effect in June 2004. Amex regulatory billings totaled $6.6 million in 2004.
DISPUTE RESOLUTION FEES totaled $80.2 million in 2004 compared with $75.5 million in 2003. Dispute resolution closed 9,209
cases in 2004, an all time record, as compared with 7,278 in 2003. In 2004, in connection with the implementation of EITF
No. 00-21, NASD changed its accounting for dispute resolution fees collected on open cases. See the Cumulative Effect of a
Change in Accounting Principle section for further discussion. Also included within dispute resolution fees are mediation fees, SRO
annual fees for forum services, neutral training fees, and other fees totaling $2.1 million and $1.7 million for the years ended
December 31, 2004 and 2003, respectively. These fees are recognized either as the cash is received or when the service is
OTHER FEES totaled $8.9 million in 2004 as compared with $9.7 million in 2003. This slight decline is due to a decrease in amounts
received from NASDAQ related to separation of NASDAQ and Amex shared technology applications. In 2002, a Master Agreement
was signed between NASD, NASDAQ, and Amex whereby NASD and NASDAQ each agreed to reimburse Amex up to $14.5 million
for costs incurred in the separation of technology applications. NASDAQ paid NASD $4.6 million in 2004 and $5.9 million in 2003
under this program. NASD then contributed those amounts, along with NASD’s matching portion, to Amex in the form of a capital
contribution. As of December 31, 2004, this program was fully funded and no further contributions are pending from either NASD
or NASDAQ. Payments from NASDAQ to NASD under this program are included in the intercompany eliminations in the
consolidating adjustments column.
ACTIVITY ASSESSMENT FEE AND COST OF REVENUES represent amounts incurred by NASD and owed to the SEC pursuant to
Section 31 of the Securities and Exchange Act of 1934. Activity assessment fees totaled $230.9 million in 2004 as compared with
NASD 2 004 ANNUAL FINANCIAL REPORT 5
$365.8 million in 2003. This decline is due mainly to a reduction in Section 31 rates charged by the SEC in 2004. In August 2004,
the SEC adopted new rules under Section 31 and provided additional guidance as to how the SEC charges SROs for these fees. As
a result of the clarifications in the new rules, NASD has begun reporting amounts owed under Section 31 on a gross basis in the
consolidated financial statements in accordance with EITF No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an
Agent.” Balances for 2003 have also been reclassified to conform to current year presentation.
FINES represent amounts billed as sanctions for rule violations, which NASD does not view to be part of operating revenues. Fines
totaled $103.9 million cash collected and $114.4 million in total in 2004 compared with $33.3 million collected in 2003, an
increase of $81.1 million or 243.5 percent. In 2004, NASD levied numerous large sanctions for issues ranging from improper
mutual fund sales and trading practices to excessive mark-ups.
NASDAQ net revenues declined $105.2 million from $589.8 million in 2003 to $484.6 million in 2004, due mainly to a decline in
NASDAQ’s market share of transactions reported to NASDAQ’s systems, the effect of price reductions, elimination of certain fees,
and the implementation of the NASDAQ General Revenue Sharing Program.
Consolidating adjustments represent the elimination of intercompany charges at the Company level, primarily contract services fees
charged to NASDAQ and Amex. Beginning in 2005, Amex contract services will no longer be eliminated as the sale of Amex to
Amex Membership Corporation was completed on December 31, 2004.
The following table summarizes total operating expenses by segment and category:
NASD CONSOLIDATED EXPENSES BY SEGMENT
YEARS ENDED DECEMBER 31,
NASD NASDAQ Consolidating Consolidated NASD NASDAQ Consolidating Consolidated
Compensation and benefits $ 306.8 $ 148.2 $ (0.2) $ 454.8 $ 267.8 $ 159.1 $ 0.2 $ 427.1
Professional and contract
services 118.5 23.7 (3.0) 139.2 116.6 37.5 (0.7) 153.4
Computer operations and
data communications 24.8 98.9 (0.3) 123.4 19.1 125.6 – 144.7
Depreciation and amortization 39.5 76.3 0.1 115.9 47.3 90.0 – 137.3
Occupancy 30.4 28.7 – 59.1 30.1 31.2 – 61.3
General and administrative 44.0 100.6 (40.2) 104.4 37.3 110.9 (58.0) 90.2
Elimination of non-core
products – – – – – 97.9 – 97.9
NASDAQ Japan impairment
gain – – – – – (5.0) – (5.0)
Total expenses $ 564.0 $ 476.4 $ (43.6) $ 996.8 $ 518.2 $ 647.2 $ (58.5) $ 1,106.9
6 NASD 2004 ANNUAL FINANCIAL REPORT
NASD total expenses were $564.0 million in 2004 compared with $518.2 million in 2003, an increase of $45.8 million in 2004 or
COMPENSATION AND BENEFITS increased $39.0 million or 14.6 percent from $267.8 million to $306.8 million due to an increase
in the number of member regulation, enforcement, and dispute resolution personnel, as well as headcount increases to service the
Amex RSA. Total NASD head count was 2,333 as of December 31, 2004 compared with 2,085 as of December 31, 2003. Also
contributing to the expense increase were costs associated with the Company’s defined benefit pension plans due to continued
reductions in the interest rate environment.
PROFESSIONAL AND CONTRACT SERVICES remained relatively consistent between years at $118.5 million in 2004 compared to
$116.6 million in 2003. Included within this overall consistent performance were increases in arbitrator payments and NASD
conference expenses offset by a reduction in consulting services due to a continuing disciplined approach to the review and
approval of new initiative spending.
COMPUTER OPERATIONS AND DATA COMMUNICATIONS totaled $24.8 million in 2004 compared to $19.1 million in 2003, an
increase of $5.7 million or 29.8 percent. This increase was attributable to new communication lines established for ADF and TRACE
in 2004, as well as additional operational costs associated with several server migrations.
DEPRECIATION AND AMORTIZATION totaled $39.5 million in 2004 compared with $47.3 million in 2003, a decline of $7.8 million
or 16.5 percent. This decline was due primarily to several assets becoming fully depreciated in the prior year. NASD has also
significantly curtailed its capital spending in recent years with the reduction in cost of technology equipment and efficient
management of the existing technology environment.
OCCUPANCY expense remained consistent between years at $30.4 million in 2004 compared with $30.1 million in 2003.
GENERAL AND ADMINISTRATIVE expenses include the company’s expenditures on matters such as travel, supplies, and marketing.
General and administrative expenses totaled $44.0 million in 2004 compared with $37.3 million in 2003, an increase of $6.7
million or 18.0 percent. The majority of this increase relates to bad debt expense on outstanding fines receivable as of
December 31, 2004, impairment recorded on software replaced in the current year, and a loss on disposal of fixed assets
associated with the migration of NASD servers in 2004. Offsetting this increase was a decline in marketing expenses due to NASD’s
mutual fund breakpoint campaign, which took place during the fourth quarter of 2003. NASD recognized $3.9 million of expense
in 2003 associated with this public awareness campaign.
Overall, NASDAQ total expenses declined significantly from 2003 to 2004. Total expenses in 2004 were $476.4 million as
compared with $647.2 million in 2003, a decrease of $170.8 million or 26.4 percent. This significant decline represents a series of
large one-time charges taken by NASDAQ in 2003 in connection with its strategic review and elimination of non-core product lines
combined with the ongoing effects of these cost reductions in 2004. In 2003, NASDAQ incurred $97.9 million in charges
associated with the elimination of non-core product lines. In 2004, the cost savings from these actions were realized. In addition,
NASDAQ continued its cost cutting measures, eliminating an additional 172 positions and reducing its overall headcount from 956
on December 31, 2003 to 786 on December 31, 2004.
NASD 2 004 ANNUAL FINANCIAL REPORT 7
Consolidating adjustments represent the elimination of intercompany charges at the Company level, primarily contract services fees
charged by NASD to NASDAQ and Amex. Beginning in 2005, Amex contract services will no longer be eliminated, as the sale of
Amex to Amex Membership Corporation was completed on December 31, 2004.
OTHER I NCOME ( EXPENSE)
The following table summarizes total other income (expense) by segment and category:
NASD CONSOLIDATED OTHER INCOME (EXPENSE) BY SEGMENT
YEARS ENDED DECEMBER 31,
NASD NASDAQ Consolidating Consolidated NASD NASDAQ Consolidating Consolidated
Interest and dividend income $ 42.7 $ 5.9 $ (13.2) $ 35.4 $ 42.0 $ 9.5 $ (8.1) $ 43.4
Interest expense (0.3) (11.5) – (11.8) (0.1) (18.6) – (18.7)
Net realized investment gains 25.7 – – 25.7 24.6 – (0.3) 24.3
Gain on Nasdaq warrants 3.9 – – 3.9 16.1 – – 16.1
Net losses from equity
investees – – – – – – (4.1) (4.1)
Minority interest benefit
(expense) – – (5.1) (5.1) – – 47.2 47.2
Total other income (expense) $ 72.0 $ (5.6) $ (18.3) $ 48.1 $ 82.6 $ (9.1) $ 34.7 $ 108.2
NASD total other income was $72.0 million in 2004 compared with $82.6 million in 2003, a decline of $10.6 million or 12.8
percent. This decline between years is primarily attributable to a reduction in the gain recognized on the change in value of
warrants to purchase NASDAQ stock from NASD. These warrants are carried at fair value with changes in the fair value recorded in
income. The fair value of these warrants is calculated using a Black-Scholes valuation model. The decline in gain recognized
between years is reflective of the passage of time and expiration of additional warrant tranches.
NASDAQ realized a decline in other expense between periods due mainly to the redemption of outstanding debt in the third
quarter of 2003. In 2003, NASDAQ redeemed the $150.0 million outstanding principal amount of senior notes due in 2007.
Consolidating adjustments represent mainly the intercompany elimination of dividends on NASDAQ preferred stock recognized by
NASD, as well as NASD’s sharing of income and losses in NASDAQ with minority interest partners. Minority interest expense
(benefit) increased from a benefit of $47.2 million in 2003 to an expense of $5.1 million in 2004, reflective of the minority interest
partners’ share of NASDAQ’s net loss in 2003 and net income in 2004.
8 NASD 2004 ANNUAL FINANCIAL REPORT
P R O V I S I O N FO R I N C O M E T A X E S
As NASD is a tax-exempt organization under the provisions of the Internal Revenue Code Section 501(c)(6), tax expenses reflected
in the Company’s consolidated financial statements represent the tax expense of NASDAQ. NASDAQ recorded a tax provision from
continuing operations in 2004, with an effective tax rate of 29.3 percent, and a tax benefit from continuing operations in 2003,
with an effective tax rate of 32.0 percent. The change from a tax benefit in 2003 to a tax provision in 2004 is related to the net
loss reported by NASDAQ in 2003 versus net income reported for 2004.
Discontinued operations in the Company’s consolidated statements reflect charges taken by both NASD Holding and NASDAQ. See
the table below for a breakdown by company by year.
YEARS ENDED DECEMBER 31,
NASD Holding $ 10.1 $ (47.4)
NASDAQ 9.6 (60.3)
Total $ 19.7 $ (107.7)
NASD Holding’s net loss from discontinued operations represents the operations of Amex for the period, net of intercompany
eliminations and taxes, as well as the estimated loss at disposal recorded as of December 31, 2004, and 2003. On October 31,
2003, NASD agreed in principle to sell its ownership interest in Amex to the Amex Membership Corporation. On December 31,
2004, NASD completed the sale of Amex to the members of Amex Membership Corporation. See Note 16, “Discontinued
Operations,” to the consolidated financial statements for further discussion.
NASDAQ’s net loss from discontinued operations in 2004 and 2003 represents amounts associated with the disposal of NASDAQ
Europe and IndigoMarkets Ltd. As a result of its strategic review, NASDAQ supported the closing of the market operated by
NASDAQ Europe. These operations were wound down pursuant to a transition plan approved by the Belgian Banking and Finance
Commission. As NASDAQ Europe was winding down its market operations, NASDAQ reached an agreement to transfer all of
NASDAQ’s shares in NASDAQ Europe to one of the original investors in NASDAQ Europe. The transfer of shares was completed in
December 2003. NASDAQ made a similar decision to discontinue operations in IndigoMarkets Ltd. In 2004, NASDAQ released a
reserve previously held to satisfy any potential claims against NASDAQ associated with the wind-down of NASDAQ Europe. See
Note 16, “Discontinued Operations,” to the consolidated financial statements for further discussion.
CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
In June 2003, the Emerging Issues Task Force finalized EITF No. 00-21, which became effective for NASD’s consolidated financial
statements on January 1, 2004. This accounting pronouncement requires revenue arrangements be reviewed to determine (a) how
the arrangement consideration should be measured, (b) whether the arrangement should be divided into separate units of
NASD 2 004 ANNUAL FINANCIAL REPORT 9
accounting, and (c) how the arrangement consideration should be allocated among the separate units of accounting. Once each
element of a revenue arrangement has been identified, EITF No. 00-21 requires companies to recognize the revenue for such
element in accordance with existing accounting principles generally accepted in the United States. EITF No. 00-21 does not address
when the criteria for revenue recognition are met or provide guidance on the appropriate revenue recognition convention for a
given unit of accounting. NASD performed a comprehensive review of all revenue arrangements and concluded that this new
accounting pronouncement was applicable to NASD’s registration and dispute resolution fees.
As a result of this implementation, NASD changed its method of accounting for revenue recognition for the initial fee component
of first year registration fees and amounts collected on open dispute resolution cases. As part of this implementation, NASD has
begun deferring and amortizing these elements over an estimated customer relationship period. With this change, NASD
recognized a one-time cumulative effect of a change in accounting principle as of January 1, 2004 of a combined $(58.3) million.
The impact to 2004 revenues for registrations and dispute resolution fees was not significant.
L I Q U I D I T Y A N D C A P I T A L RE S O U R C E S
Consistent with the Company’s operation of its business segments as separate stand-alone companies each with its own corporate
governance, NASD and NASDAQ separately manage their liquidity and capital resources. Each segment’s Board has approved its
respective investment policies for internally and externally managed portfolios.
NASD’s investment policy has been developed based on best practices as applied to its investment objectives. The NASD Investment
Committee, whose members have extensive background and experience in the investment community, provides overall guidance
and advice in determining the appropriate policy, guidelines, and allocation for these investments. NASD engages an investment
consultant to support the Investment Committee in the areas of policy and guidelines, and to monitor the performance of the
portfolio and investment managers, including periodic selection and evaluation of asset managers.
The goal of NASD’s investment policy is to generate long-term returns to be used to support NASD operations for the benefit of
investors and members, to preserve the real purchasing power of those funds for future contingencies, and to maintain financial
balance sheet strength. Portfolio returns may be used for funding current operating budget needs, maintaining real purchasing
power for future contingencies, or for other strategic or operational purposes. NASD’s targeted investment portfolio allocations are
50 to 65 percent equities, 20 to 30 percent fixed income, and 15 to 20 percent alternative investments.
The NASDAQ Board of Directors separately reviews and approves the investment policy for NASDAQ and its subsidiaries. The goal
of NASDAQ’s investment policy is to maintain adequate liquidity at all times, to fund current budgeted operating and capital
requirements and to maximize returns. All securities must meet credit rating standards as established by the policy. The investment
duration must not exceed 18 months. Beginning October 2003, the policy prohibits the purchasing of equity securities.
Both NASD and NASDAQ rely on cash flows from operations to provide working capital for current and future operations. The
Company’s net cash provided by operating activities was $156.2 million and $241.1 million for 2004 and 2003, respectively. Net
cash used in investing and financing activities by the company in 2004 and 2003 was a combined $365.1 million and $240.3
10 NASD 2004 ANNUAL FINANCIAL REPORT
See table below for total cash flows by segment between years:
YEARS ENDED DECEMBER 31,
NASD NASDAQ Total NASD NASDAQ Total
Continuing $ 46.5 $ 107.5 $ 154.0 $158.5 $145.8 $304.3
Discontinued operations (7.4) 9.6 2.2 (22.7) (40.5) (63.2)
Total operating 39.1 117.1 156.2 135.8 105.3 241.1
Investing (163.6) (201.3) (364.9) (83.1) (0.2) (83.3)
Financing 6.3 (6.5) (0.2) 0.6 (157.6) (157.0)
Total $ (118.2) $ (90.7) $ (208.9) $ 53.3 $ (52.5) $ 0.8
During 2004, NASD generated net cashflows from continuing operations of $46.5 million due primarily to net income for the year
offset by a reduction in the SEC fee payable of $83.9 million, which is due to the rate change by the SEC of the Section 31
assessment by 50.0 percent. NASD incurred investing cash outflows of $163.6 million in 2004, associated with changes in fund
managers and the purchase of additional securities as part of the implementation of NASD’s new investment policy, which was
approved by the NASD Board in early 2004. Also included in investing cash outflows were capital expenditures of $28.5 million in
2004 related primarily to the acquisition of storage, servers, and backup equipment associated with the upgrade of NASD’s disaster
recovery environment, as well as capitalized software development costs and minor building enhancements. In 2003, capital
expenditures were $19.2 million. Financing cash flows were $6.3 million in 2004.
NASD has been able to generate sufficient funds from operations to meet working capital requirements. NASD has a $50.0 million
line of credit available through November 2005, had it temporarily needed liquidity to meet its current obligations. The Company
believes that the liquidity provided by existing cash and cash equivalents, investments, and cash generated from operations will
provide sufficient capital to meet current and future operating requirements.
NASD working capital was $995.7 million at December 31, 2004, compared with $961.6 million at December 31, 2003.
Cash flows from continuing operations activities totaled $107.5 million in 2004 and $145.8 million in 2003. The decrease in
operating cash flows was primarily due to payments for the elimination of non-core product lines, initiatives, and severance. Net
cash used in investing and financing activities was $207.8 million in 2004 and $157.8 million in 2003. Capital expenditures for
2004 were $26.0 million compared with $31.6 million in 2003. In 2003, NASDAQ redeemed $150.0 million in Senior Notes, which
are included in financing activities.
NASD 2004 ANNUAL FINANCIAL REPORT 11
CONTRACTUAL OBLIGATIONS AND CONTINGENT COMMITMENTS
The Company has contractual obligations to make future payments under several contracts. A combined summary of those
contractual obligations is provided below.
CONTRACTUAL OBLIGATIONS AND CONTINGENT COMMITMENTS
Less than 1-3 3-5 More than
Total 1 Year Years Years 5 Years
Long-term debt by contract maturity (NASDAQ) $ 265.0 $ – $ 241.5 $ 5.0 $ 18.5
Minimum rental commitments under non-cancelable operating leases, net 396.8 57.8 72.2 50.7 216.1
Minimum rental commitments under capitalized leases 1.6 0.7 0.9 – –
Other long-term obligations 204.1 52.6 54.7 45.7 51.1
Total $ 867.5 $ 111.1 $ 369.3 $ 101.4 $ 285.7
Long-term debt represents NASDAQ’s $25.0 million senior note payable and NASDAQ’s $240.0 million convertible subordinated
notes. Principal payments on the $25.0 million note are scheduled to begin in 2007 and continue in equal monthly installments
until maturity in 2012. The $240.0 million convertible subordinated notes become due in May of 2006. See Note 9, “Long Term
Debt,” to the consolidated financial statements for further discussion.
Minimum rental commitments under non-cancelable operating leases represent totals of NASD and NASDAQ. The majority of
these leases contain escalation clauses based on increases in property taxes and building operating costs. Of the amounts
presented, NASD operating lease commitments totaled $153.7 million and NASDAQ commitments were $243.1 million.
Commitments under capitalized leases are solely attributable to NASD.
Other long-term obligations reflect NASD’s information and technology services agreement with EDS, NASDAQ’s global services
agreement with MCI, and contracts between Brut and SunGard for on-line processing, hosting, and other related services.
NASD and NASDAQ are currently awaiting the SEC’s decision on Exchange Registration for NASDAQ. Upon Exchange Registration,
NASD will no longer exert voting control over NASDAQ and, as such, NASD expects that it will cease to consolidate NASDAQ. The
following discussion details steps taken to date in the disposition of NASDAQ and the impact on the consolidated operations of the
Previous NASD transactions in NASDAQ stock include Phase I and Phase II sales of NASDAQ common shares and warrants in 2000
and 2001. On May 3, 2001, NASD further decreased its ownership through a two-part transaction, which resulted in the issuance
of convertible debt by NASDAQ to the private equity firm of Hellman & Friedman, and the subsequent repurchase of shares by
NASDAQ from NASD.
In March 2002, NASD sold 33.8 million shares of NASDAQ common stock to NASDAQ, reducing its ownership of NASDAQ to 55
percent prior to the exercise of warrants. Assuming the full exercise of all warrants purchased in Phase I and II of the NASDAQ
restructuring, this transaction effectively reduced NASD’s ownership of NASDAQ common shares to zero on a fully diluted basis. In
exchange for the shares sold, NASDAQ paid NASD $305.2 million in cash, issued 1,338,402 shares of Series A Cumulative
Preferred Stock, and one share of Series B Preferred Stock.
12 NASD 2004 ANNUAL FINANCIAL REPORT
With its 54.7 percent ownership and one share of Series B Preferred Stock, NASD continues to exert voting control over NASDAQ
and therefore continues to consolidate NASDAQ’s operations under accounting principles generally accepted in the United States.
NASDAQ applied for registration as an exchange with the SEC in March 2001. If Exchange Registration is approved, warrant
holders will have the right to direct the voting of the shares of NASDAQ common stock underlying the unexercised and unexpired
warrants. At that time, NASD will no longer exert voting control and will cease to consolidate NASDAQ’s operations in the
Company’s consolidated financial statements.
The table below summarizes the effect of all NASD and NASDAQ transactions in NASDAQ stock during the period June 2000 to
EFFECT OF NASDAQ RESTRUCTURING ACTIVITIES (DOLLARS IN MILLIONS)
NASD Fully Shares Increase in Decrease in
Ownership Diluted Owned by Consolidated Minority Increase in Consolidated
% % NASD Equity Interests Liabilities Cash Proceeds
Year Ended 12/31/99—after
stock split 100.0% 100.0% 100,000,000 $ – $ – $ – $ –
Cumulative Activity ‘00 & ‘01 (31.0)% (74.7)% (23,005,129) (247.5) (140.6) (368.6) 756.7
Year Ended 12/31/01 69.0% 25.3% 76,994,871 (247.5) (140.6) (368.6) 756.7
NASDAQ Share Buyback—
March 2002 *** (13.5)% (25.3)% (33,768,895) (122.9) 122.9 – –
Other NASDAQ & Warrant Exercises (0.3)% – (20,830) (1.0) (1.2) – 2.2
Impact-Year Ended 12/31/02 55.2% – 43,205,146 (371.4) (18.9) (368.6) 758.9
Warrant Exercises & Expirations – 13.7% (15,000) – – – 0.2
Other NASDAQ (0.2)% – – (0.8) (0.7) – 1.5
Impact-Year Ended 12/31/03 55.0% 13.7% 43,190,146 (372.2) (19.6) (368.6) 760.6
Warrant Exercises & Expirations – 13.7% (6,750) – – – 0.1
Other NASDAQ (0.3)% (0.1) – (1.3) (1.0) – 2.3
Impact-Year Ended 12/31/04 54.7% 27.3% 43,183,396 (373.5) (20.6) (368.6) 763.0
Secondary Offering—February 2005 (21.0)% (21.0)% (16,586,980) (135.2) (5.5) – 140.7
Year-Ended 12/31/04—Proforma 33.7% 6.3% 26,596,416 $ (508.7) $ (26.1) $ (368.6) $ 903.7
Cash Proceeds—NASD * $ 871.8
Cash Proceeds—NASDAQ ** 31.9
Total Cash Proceeds $ 903.7
* Reflects the effect of two NASDAQ buybacks of its shares from NASD amounting to $240.0 million (the Hellman & Friedman transaction in
2001) and $305.2 million (the March 2002 transaction).
** Reflects the $240.0 million as a pass through and the $305.2 million as a payment to NASD out of proceeds received during Phase I and II.
*** In connection with the March 2002 share buyback NASD also received 1,338,402 shares of Series A Cumulative Preferred Stock and one share
of Series B Preferred Stock.
NASD 2 004 ANNUAL FINANCIAL REPORT 13
Warrants to purchase NASDAQ common shares are exercisable in four annual tranches. As of December 31, 2004, the first two
warrant tranches have expired with only 42,580 warrants having been purchased through the exercise of warrants. The third
warrant tranche is set to expire on June 27, 2005 and the final warrant tranche is due to expire on June 27, 2006. Exercise prices
for the third and fourth warrant tranches are $15 and $16 per share, respectively.
On September 30, 2004, NASD waived a portion of the dividend on the Series A Cumulative Preferred Stock for the third quarter
of 2004 of $2.5 million and accepted an aggregate amount of $1.0 million (calculated based on an annual rate of 3.0 percent) as
payment in full of the dividend for this period. On November 29, 2004, NASD entered into an exchange agreement with NASDAQ
pursuant to which NASD exchanged 1,338,402 shares of NASDAQ’s Series A Cumulative Preferred Stock, for 1,338,402 shares of
newly issued Series C Cumulative Preferred Stock. The Series C Cumulative Preferred Stock accrues quarterly dividends at an annual
rate of 3.0 percent for all periods until July 1, 2006 and at an annual rate of 10.6 percent for periods thereafter. NASD also may be
entitled to an additional payment in certain circumstances, which may not exceed $16.3 million in aggregate depending on the
amount of time the Series C Cumulative Preferred Stock is outstanding and the market price of NASDAQ’s common stock at the
time NASDAQ redeems the Series C Cumulative Preferred Stock. Shares of Series C Cumulative Preferred Stock do not have voting
rights, except for the right as a class to elect two new directors to the Board of Directors any time distributions on the Series C
Cumulative Preferred Stock are in arrears for four consecutive quarters and as otherwise required by Delaware law.
On February 15, 2005, NASDAQ completed an underwritten secondary offering of 16,586,980 shares of common stock owned by
NASD and an additional 3,246,536 shares of common stock owned by certain selling stockholders who purchased the shares in
NASDAQ’s private placements in 2000 and 2001. NASDAQ, its officers, or other employees did not sell any shares in the secondary
offering. NASD received net proceeds of $140.7 million and recognized a gain on the sale of subsidiary stock of $135.1 million. As
of February 15, 2005, NASD owned 33.7 percent of NASDAQ’s common stock, 100.0 percent of NASDAQ Series C Cumulative
Preferred Stock, and 100.0 percent of NASDAQ Series B Preferred Stock. Due to the voting rights of the Series B Preferred Stock,
NASD will continue to consolidate NASDAQ.
Q U A N T I T A T I V E A N D Q U A L I T A T I V E D I S C L O S U R E A B O U T MA R K E T R I S K
Market risk represents the risks of changes in value of a financial instrument, derivative or non-derivative, caused by fluctuations in
interest rates, foreign exchange rates, and equity prices. As of December 31, 2004, investments in the Company’s consolidated
financial statements consisted of equities, U.S. Treasury securities, obligations of U.S. Government-sponsored enterprises, and
other financial instruments.
The Company’s primary market risk is with respect to its investment portfolio and is associated with fluctuations in the equities
markets, as well as fluctuations in interest rates and the effects that both types of fluctuations may have on its investment portfolio
and outstanding debt.
NASDAQ’s investment portfolio is held primarily in investments with maturities averaging less than one year and NASDAQ’s debt
obligations generally specify a fixed interest rate. Therefore, NASDAQ does not believe that a 100 basis-point fluctuation in market
interest rates will have a material effect on the carrying value of the investment portfolio or earnings or cash flows.
NASD’s investment portfolio also contains fixed income securities. However, NASD’s fixed income securities have a longer maturity
than NASDAQ’s, with a duration, or weighted average maturity of cash flows, of approximately 3.0 years as of December 31,
2004. Duration is a measure of the sensitivity of a fixed income portfolio to a change in interest rates: for every 100 basis point
change in interest rates, a portfolio with a duration of 3.0 years is expected to change inversely by 3.0 percent. NASD believes that
any decline in the value of its fixed income securities due to a 100 basis point increase in interest rates should be largely offset by
the portfolio’s yield of approximately 3.8 percent.
14 NASD 2004 ANNUAL FINANCIAL REPORT
NASD maintains a portion of its portfolio in equity securities, which have been more sensitive to market fluctuations. NASD reviews
its investment portfolio for other-than-temporary declines on a quarterly basis. Based on these reviews, NASD recorded impairment
charges for other-than-temporary declines of $3.1 million and $0.1 million in 2004 and 2003, respectively. NASD management
believes that other-than-temporary fluctuations in market indices could have a significant impact on NASD’s investment portfolio
and earnings and cash flows.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of the Company’s financial statements in conformity with generally accepted accounting principles requires
management to adopt accounting principles and make estimates and judgments to develop amounts reported in the financial
statements and accompanying notes.
The Company periodically reviews the application of its accounting policies and evaluates the appropriateness of the estimates that
are required to prepare the financial statements. The Company believes its estimates and judgments are reasonable; however,
actual results and the timing of recognition of such amounts could differ from those estimates.
The Company’s significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” to the
consolidated financial statements. The following provides information about the Company’s critical accounting policies, which are
defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results
under different assumptions and conditions. At the consolidated level, the Company has determined that the critical accounting
policies are those that cover investments, revenue recognition, software costs, impairment of long-lived assets, and pension
Under SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” management determines the
appropriate classification of investments at the time of purchase. Investments for which the Company does not have the intent or
ability to hold to maturity are classified as “available-for-sale” and are carried at fair value, with any unrealized gains and losses,
net of tax, reported as a separate component of members’ equity. Investments for which the Company has the intent and ability to
hold to maturity are classified as “held-to-maturity” and are carried at amortized cost. The amortized cost of debt securities
classified as held-to-maturity is adjusted for amortization of premiums and accretion of discounts. Fair value is determined based
on quoted market prices when available, or if quoted market prices are not available, on discounted expected cash flows using
market rates commensurate with the credit quality and maturity of the investment. Realized gains and losses on sales of securities
are included in earnings using the average cost method. Amounts due to or from the custodial agent relate to security trades
executed prior to the balance sheet date but not yet settled.
The Company reviews its investments quarterly to determine whether a decline in fair value below cost basis is other-than-
temporary. If the decline in the fair value is judged to be other-than-temporary, the cost basis of the investment is written down to
fair value, the amount of the write-down is charged to earnings, and a new cost basis for the security is established.
REVENUE RECOGNITION AND COST OF REVENUE
Market services include the NASDAQ Market Center and NASDAQ market services subscriptions revenues. NASDAQ Market Center
revenues are variable, based on service volumes, and recognized as transactions occur. NASDAQ market services subscriptions
revenues are based on the number of presentation devices in service and quotes delivered through those devices. NASDAQ market
services subscriptions revenues are recognized in the month that information is provided and are recorded net of amounts due
NASD 2 004 ANNUAL FINANCIAL REPORT 15
under revenue sharing arrangements with market participants. Pursuant to EITF No. 99-19, “Reporting Revenues Gross vs. Net,”
execution revenues from transactions executed through Brut are recorded on a gross basis in revenues. Expenses, such as the
liquidity rebate payments, are recorded in cost of revenues as Brut acts as principal. NASDAQ’s other execution revenues will
continue to be reported net of the liquidity rebate as NASDAQ does not act as principal.
Issuer services consist primarily of annual listing fees, initial listing (IL) fees and listing of additional shares (LAS) fees on The
NASDAQ Stock Market. Annual listing service revenues are recognized ratably over the following 12-month period. IL and LAS fees
are recognized on a straight-line basis over estimated customer relationship periods. NASDAQ receives license fees for its
trademark licenses related to the QQQ and other financial products linked to NASDAQ indices issued in the U.S. and abroad. These
revenues are recognized as earned.
Regulatory fees represent fees to fund NASD’s member regulatory activities, including the supervision and regulation of members
through examinations, processing of membership applications, financial monitoring, policy, rulemaking, interpretive, and
enforcement activities. Regulatory fees are recorded net of any member rebates. Regulatory fees include a trading activity fee,
gross income assessment, personnel assessment, and branch office assessment. The trading activity fee is assessed on the sell side
of all member transactions in all covered securities regardless of where the trade is executed and is assessed directly to the firm
responsible for clearing the transaction on behalf of the member firm. The trading activity fee is recognized as the transaction
occurs. Gross income assessments, personnel assessments, and branch office assessments represent annual fees charged to
member firms and representatives and are recognized ratably over the annual period to which they relate.
User fees consist of fees charged for initial and annual registrations, qualification exams, fees associated with NASD sponsored
meetings and conferences, and charges related to the review of advertisements and corporate filings. Registration fees include
both an initial and annual fee charged to all NASD-registered representatives. The initial fee is recognized over the estimated
customer relationship period and the annual fee over the related annual period. Qualification fees consist of examination and
continuing education fees, which are recognized as the exam is given or continuing education program is held. Advertising
represents fees charged for the review of NASD member firms’ communications to ensure that they are fair, balanced, and not
misleading. Advertising fees are recognized as revenue as the review is completed. Corporate financing consists of fees charged by
NASD for reviewing proposed public offerings and are recognized as the review is completed.
Dispute resolution fees consist of fees earned during the arbitration and mediation processes. Fees on open cases are recognized as
revenue over the average life of a case. Upon closing of a case, a final billing is prepared and any unpaid fees are recognized as
revenue at that time. Also included in dispute resolution fees are mediation fees, SRO annual fees for forum services, neutral
training fees, and other fees, which are recognized either when the cash is received or when the service is provided.
Transparency services for NASD represent fees charged through NASD’s TRACE and ADF. TRACE represents fees charged on
secondary market transactions in eligible fixed income securities reported to NASD, TRACE system-related fees, and TRACE market
data fees. ADF is a facility for posting quotes, and reporting and comparing trades. TRACE and ADF fees are recognized as the
Contract service fees represent amounts charged by NASDR for regulatory services provided under contractual arrangements and
are recognized as revenue as the regulatory service is provided.
NASD, as an SRO, pays certain fees and assessments to the SEC pursuant to Section 31 of the Securities and Exchange Act of
1934. These fees are designed to cover costs incurred by the government in the supervision and regulation of securities markets
and securities professionals and are based on a percentage of the total dollar value of securities sold in The NASDAQ Stock Market,
the ADF, and the over-the-counter (OTC) Bulletin Board. NASD remits these fees to the U.S. Treasury semiannually in March and
September. In 2004, the SEC adopted new rules under Section 31 and provided SROs additional guidance as to how the SEC
charges SROs for these fees, which affected NASD’s accounting treatment for such fees in its consolidated financial statements.
16 NASD 2004 ANNUAL FINANCIAL REPORT
NASD recovers the cost of the SEC’s fees and assessments through an activity assessment billed to securities firms based on the
total dollar value of securities sold in The NASDAQ Stock Market, the ADF, and the OTC Bulletin Board. The assessments billed to
securities firms are recognized when the transactions occur. Beginning in 2004, NASD reported the activity assessment on a gross
basis within revenues in accordance with EITF No. 99-19. Amounts due to the SEC are reported as a cost of revenue. The effect of
this change had no impact on NASD’s consolidated net income.
Fines represent sanctions for rule violations. Commencing in 2004, fines are recognized when the fine is assessed.
Significant purchased application software, and operational software that is an integral part of computer hardware, are capitalized
and amortized using the straight-line method over their estimated useful lives, generally two to seven years. All other purchased
software is charged to expense as incurred. In accordance with Statement of Position No. 98-1, “Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use,” the Company capitalizes internal computer software development
costs incurred during the application development stage. Computer software costs incurred prior to or subsequent to the
application development stage are charged to expense as incurred.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets.” In the event that facts and circumstances indicate that long-lived assets or other assets may be
impaired, an evaluation of recoverability would be performed. If an evaluation were required, the estimated future undiscounted
cash flows associated with the asset would be compared to the asset’s carrying amount to determine if a write-down is required. If
impairment were indicated, the Company would prepare a discounted cash flow analysis to determine the amount of the
The Company provides three non-contributory defined benefit pension plans for the benefit of eligible employees of its
subsidiaries. The non-contributory defined benefit plan consists of a funded Employee Retirement Plan and two unfunded
Supplemental Executive Retirement Plans. Several statistical and other factors, which attempt to anticipate future events, are used
in calculating the expense and liability related to the plans. Key factors include assumptions about the expected rates of return on
plan assets and discount rates as determined by the Company, within certain guidelines. The Company considers market
conditions, including changes in investment returns and interest rates, in making these assumptions. The Company determines the
long-term rate of return based on analysis of historical and projected returns as prepared by the Company’s actuary and external
investment consultant. The discount rate used in the calculations is tracked to changes in Moody’s Aa bond ratings. The
Company’s Pension Plan Committee approves both the expected long-term rate of return and the discount rate assumptions.
Unrecognized actuarial gains and losses are being recognized over time in accordance with SFAS No. 87, “Employers Accounting
for Pensions.” Unrecognized actuarial gains and losses arise from several factors including experience and assumption changes in
the obligations, and from the difference between expected returns and actual returns on plan assets.
The actuarial assumptions used by the Company in determining its pension benefits may differ materially from actual results due to
changing market conditions and economic conditions, as well as early withdrawals by terminating plan participants. While the
Company believes that the assumptions used are appropriate, differences in actual experience or changes in assumptions may
materially affect the Company’s financial position or results of operations.
NASD 2 004 ANNUAL FINANCIAL REPORT 17
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment”
(SFAS No. 123(R)), which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 123(R) supersedes
Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and amends SFAS No. 95,
“Statement of Cash Flows.” Generally the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123.
However, SFAS No. 123(R) requires NASDAQ to expense, in the consolidated statements of income, all share-based payments to
employees, including grants of employee stock options, based on their fair values. This cost will be recognized over the vesting
period of the grants. Pro forma disclosure will no longer be an alternative. NASDAQ cannot predict the impact of adoption of SFAS
No. 123(R) because the impact will depend on the levels of share-based payments granted in the future. However, had NASDAQ
adopted SFAS No. 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as
described in the disclosure of pro forma net income and earnings per share in Note 12, “NASDAQ Stock Compensation, Stock
Awards, and Capital Stock,” to the consolidated financial statements. In April 2005, the SEC announced the adoption of a new
rule allowing companies to implement SFAS No. 123(R) at the beginning of their next fiscal year that begins after June 15, 2005.
In March 2004, the Emerging Issues Task Force issued EITF No. 03-1, “The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments,” which provides new guidance for assessing impairment losses on debt and equity
investments. Additionally, EITF No. 03-1 includes new disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the FASB voted to delay the accounting provisions of EITF No. 03-1; however, the disclosure
requirements remain effective and have been adopted for the Company’s year ended December 31, 2004 financial statements and
are included in Note 6 “Investments” to the consolidated financial statements. Once issued, the Company will evaluate the impact
of adopting the accounting provisions of EITF No. 03-01.
18 NASD 2004 ANNUAL FINANCIAL REPORT
CERTIFICATION FOR 2004 ANNUAL FINANCIAL REPORT
We, Robert R. Glauber and Todd T. Diganci, certify that:
1. We have reviewed this annual financial report of the National Association of Securities Dealers, Inc. (NASD);
2. The purpose of this report is principally to set forth management’s report on financial operations with respect to NASD
during the years ended December 31, 2004, together with the consolidated financial statements of NASD as of and for
the year ended December 31, 2004 and 2003, and this report is not intended to comply with the substantive or form
requirements for periodic reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and the
rules and regulations promulgated thereunder (the “Exchange Act Rules and Regulations”) required of issuers of
securities subject to the periodic reporting requirements under Sections 12, 13 and 15 of the Exchange Act of 1934 and
the related Exchange Act Rules and Regulations;
3. Based on our knowledge, this report does not contain any untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
4. Based on our knowledge, the financial statements and other financial information set forth under the caption
“Management Report on Financial Operations”, fairly present in all material respects the financial condition, results of
operations and cash flows of NASD as of, and for, the periods presented in this report;
5. NASD has established disclosure controls and procedures to ensure that material information relating to NASD, including
its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which
this report is being prepared;
6. NASD has carried out its evaluation of the effectiveness of the design and operation of NASD’s disclosure controls and
procedures as of December 31, 2004. Based upon that evaluation, we have concluded that the disclosure controls and
procedures are effective;
7. We have disclosed, based on NASD’s most recent evaluation of internal control over financial reporting, to NASD’s
auditors and the Audit Committee of NASD’s Board of Directors:
a) Any significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect NASD’s ability to record, process, summarize and report
financial information; and
b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
NASD’s internal control over financial reporting.
Date: May 17, 2005
Robert R. Glauber
Chairman and CEO
Todd T. Diganci
Executive Vice President and C FO
NASD 2 004 ANNUAL FINANCIAL REPORT 19
AUDIT COMMITTEE REPORT
In accordance with its written Charter adopted by the Board of Governors, the Audit Committee of the Board of Governors assists
the Board in fulfilling its responsibility for oversight of the quality and integrity of the accounting, auditing, and financial reporting
practices of NASD. Each member of the Committee is an independent director as defined by SEC Rule 10A-3 under The Securities
and Exchange Act of 1934, Listing Standards Relating to Audit Committees. In addition, the Audit Committee and Board of
Governors have determined that James E. Burton and Charles A. Bowsher are audit committee financial experts, as defined by the
SEC. The Charter gives the Audit Committee responsibility for monitoring the independence of the independent auditors and
recommending the appointment of the independent auditors for approval by the Board of Governors, and makes clear that the
independent auditors are accountable to the Audit Committee and the Board of Governors, as representatives of the members and
the public. In all respects, the Charter complies with standards applicable to publicly owned companies. In addition, the Charter
and the By-laws of NASD make the Director of Internal Audit directly responsible to the Audit Committee. (The Charter for the
NASD Audit Committee is available on the Internet at the following URL: http://www.nasd.com/auditcommittee.)
During 2004, the Committee met seven times, with the Committee members having a 94% attendance rate.
In discharging its oversight responsibility, the Audit Committee reviewed the assessments of audit risk and the audit plans of both
the independent and internal auditors. The Audit Committee also discussed with management, the internal auditors, and the
independent auditors the quality and adequacy of NASD’s internal controls and the internal audit organization, responsibilities,
budget, and staffing.
The Audit Committee obtained a written statement from the independent auditors describing all relationships with NASD. The
Audit Committee discussed those relationships and satisfied itself that none of the relationships were incompatible with the
auditors’ independence. The Committee has reviewed and approved all services performed by NASD’s independent auditors, Ernst
and Young LLP, and the associated fees, before initiation of each engagement. Such services and fees are summarized in the
INDEPENDENT PUBLIC ACCOUNTANT (IPA) FEES
NASD (6) NASDAQ (5) Amex (6) Total
2004 2003 2004 2003 2004 2003 2004 2003
Audit services (1) $ 656,440 $ 571,197 $ 2,307,100 $ 1,857,159 $ 258,000 $ 241,500 $ 3,221,540 $ 2,669,856
Audit-related services (2) 447,784 329,251 278,314 191,200 8,456 49,275 734,554 569,725
Tax services (3) 17,188 36,441 100,000 435,325 – – 117,188 471,766
Other services (4) – – – 6,900 – – – 6,900
Total $ 1,121,412 $ 936,889 $ 2,685,414 $ 2,490,584 $ 266,456 $ 290,775 $ 4,073,282 $ 3,718,247
(1) Audit services for NASD and Amex represent fees for the year-end financial statement audits. Audit services for NASDAQ represent fees
associated with the audit, inclusive of international entities, of NASDAQ’s annual financial statements, the review of NASDAQ’s quarterly
reports on Form 10-Q, and accounting consultations on matters addressed during the audit or interim review. In addition, NASDAQ audit fees
for 2004 include attestation procedures in connection with the internal control reporting requirements of Section 404 of the Sarbanes-Oxley
Act of 2002.
(2) Audit-related services in 2004 and 2003 for NASD reflect fees associated with special purpose audits and agreed-upon procedures such as
IARD, CRD, employee benefit plans, as well as audit related services associated with the planned disposition of Amex and separation from
NASDAQ. Also included in NASD audit-related services are advisory fees associated with the initial phases of NASD’s implementation of the
principles embodied in Section 404. NASDAQ audit-related fees represent assurance and employee benefit plan audits. NASDAQ audit-related
services also include internal control reviews including reviewing Section 404 internal control program design.
20 NASD 2004 ANNUAL FINANCIAL REPORT
(3) Tax services represent fees related to tax compliance, advice, and planning.
(4) For 2003, other services for NASDAQ represent client advisory services and products.
(5) NASDAQ IPA services and fees are separately reviewed and approved by the NASDAQ Audit Committee. The NASD Audit Committee has
oversight of the NASDAQ Audit Committee, but does not review actions taken with respect to the approval of IPA fees. NASDAQ fees exclude
services provided to non-profit entities of The Nasdaq Stock Market, Inc., services provided in relation to NASDAQ’s role as the Securities
Information Processor under the Unlisted Trading Privileges Plan and the audit of the NASDAQ-100 Trust, Series 1, the trust for the NASDAQ-
100 Index Tracking Stock, also known as QQQ. NASDAQ also incurred fees payable to Deloitte & Touché, LLP (Deloitte & Touché) for fiscal year
ended 2004, totaling $226,750. On September 7, 2004, NASDAQ completed its acquisition of Toll Associates LLC and affiliated entities from
SunGard Data Systems Inc., which includes Brut, LLC. These fees represent audit fees on the consolidated financial statements of Toll
Associates as of December 31, 2004 and for the period September 7, 2004 through December 31, 2004. Deloitte & Touché was the
independent registered public accounting firm for Toll Associates before the acquisition and, given their historical knowledge, the NASDAQ
Audit Committee chose to continue the relationship through the remainder of 2004.
(6) NASD and Amex fees for 2004 are based on fees approved by NASD’s Audit Committee as of April 20, 2005. The 2004 audit services and
audit-related services include estimates to complete the current work in process. Fees included in 2003 were generally paid between July 1,
2003 and June 30, 2004. NASD 2003 fees have been updated from the prior year report to reflect final amounts paid for the 2003 approved
The Audit Committee discussed and reviewed with the independent auditors all communications required by generally accepted
auditing standards and, with and without management present, discussed the results of the independent auditors’ examination of
the financial statements. Based on those discussions, the Audit Committee recommended to the Board of Governors that NASD’s
audited financial statements be included in the Annual Report for the year ended December 31, 2004.
Members of the Audit Committee:
James E. Burton, Chair
John W. Bachmann
M. LaRae Bakerink
Charles A. Bowsher
May 9, 2005
NASD 2 004 ANNUAL FINANCIAL REPORT 21
REPORT OF INDEPENDENT AUDITORS
BOARD O F GOVERNORS
NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC.
We have audited the accompanying consolidated balance sheets of the National Association of Securities Dealers, Inc. (NASD) as of
December 31, 2004 and 2003, and the related consolidated statements of income, changes in members’ equity, and cash flows for
the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our audits. We did not audit the consolidated financial statements of
Toll Associates LLC, a partially owned subsidiary, which statements reflect 10.3% of consolidated total assets at December 31,
2004 and 4.6% of total consolidated revenues for the year then ended. Those statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Toll Associates LLC, is based
solely on the report of other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit
included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in
the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly we express no such opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We believe that our audits, and the report of other
auditors, provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of NASD at December 31, 2004 and 2003, and the consolidated results of its
operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the
As discussed in Note 5 to the consolidated financial statements, in 2004 the Company changed its method of accounting for
certain registration and arbitration revenues.
April 29, 2005
22 NASD 2004 ANNUAL FINANCIAL REPORT
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
Cash and cash equivalents $ 123,834 $ 332,784
Available-for-sale, at fair value 1,391,859 1,309,307
Held-to-maturity, at amortized cost 28,600 23,765
Receivables, net 151,830 175,254
Receivables from related parties 4,946 –
Deferred tax assets 24,209 40,460
Other current assets 21,056 22,728
Current assets—discontinued operations – 120,511
Total current assets 1,746,334 2,024,809
Held-to-maturity investments, at amortized cost 2,008 4,506
Property and equipment:
Land, buildings, and improvements 172,350 169,216
Data processing equipment and software 369,239 529,522
Furniture, equipment and leasehold improvements 264,442 305,073
Less accumulated depreciation and amortization (492,186) (605,661)
Total property and equipment, net 313,845 398,150
Non-current deferred tax assets 48,765 109,479
Note receivable from Amex 25,000 –
Goodwill 141,381 –
Intangible assets, net 44,260 5,322
Other assets 33,125 34,235
Non-current assets—discontinued operations – 32,785
Total assets $ 2,354,718 $ 2,609,286
See accompanying notes.
NASD 2 004 ANNUAL FINANCIAL REPORT 23
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
Liabilities and members’ equity
Accounts payable and accrued expenses $ 65,026 $ 65,748
SEC fee payable 68,275 152,198
Accrued personnel and benefit costs 145,557 134,855
Deferred revenue 137,523 96,546
Deposits and renewals 63,032 67,220
Capital lease obligation 737 2,320
Due to custodial agent 17,696 124,973
Due to related parties 450 –
Other current liabilities 70,043 126,559
Current liabilities—discontinued operations – 102,924
Total current liabilities 568,339 873,343
Accrued pension and other post retirement benefit costs 57,794 41,307
Long-term debt 265,000 265,000
Non-current deferred tax liabilities 29,514 78,317
Non-current capital lease obligation 868 1,654
Deferred revenue 107,061 84,703
Warrants to purchase NASDAQ stock from NASD 3,836 7,744
Other liabilities 49,343 46,990
Non-current liabilities—discontinued operations – 41,280
Total liabilities 1,081,755 1,440,338
Minority interest 11,938 12,034
Commitments and contingencies
Members’ equity 1,194,043 1,120,191
Unrealized gain on available-for-sale investments 74,131 39,442
Foreign currency translation 988 875
Minimum pension liability (8,137) (3,594)
Total members’ equity 1,261,025 1,156,914
Total liabilities and members’ equity $ 2,354,718 $ 2,609,286
See accompanying notes.
24 NASD 2004 ANNUAL FINANCIAL REPORT
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS)
YEARS ENDED DECEMBER 31,
Market services $ 332,540 $ 383,580
Issuer services 201,458 204,166
Regulatory fees, net of member rebates of $30,000 in 2004 and $25,000 in 2003 222,844 174,225
User fees 137,277 128,382
Dispute resolution fees 80,181 75,453
Transparency services 14,736 21,139
Contract service fees 4,693 2,570
Other 2,321 4,658
Total operating revenues 996,050 994,173
Activity assessment 230,853 365,803
Fines 114,414 33,329
Total revenues 1,341,317 1,393,305
Cost of revenues:
SEC activity remittance (230,853) (365,803)
Other (55,845) –
Total cost of revenues (286,698) (365,803)
Net Revenues 1,054,619 1,027,502
Compensation and benefits 454,827 427,094
Professional and contract services 139,182 153,376
Computer operations and data communications 123,443 144,712
Depreciation and amortization 115,867 137,300
Occupancy 59,081 61,308
General and administrative 104,354 90,197
Elimination of non-core product lines, initiatives, and severance – 97,910
NASDAQ Japan impairment gain – (5,000)
Total expenses 996,754 1,106,897
Net revenues less expenses 57,865 (79,395)
Other income (expense)
Interest and dividend income 35,348 43,355
Interest expense (11,773) (18,702)
Net realized investment gains 25,684 24,327
Gain on NASDAQ warrants 3,909 16,080
Net losses from equity investees – (4,102)
Minority interest (expense) benefit (5,149) 47,203
Income before income taxes, discontinued operations,
and cumulative effect of change in accounting principle 105,884 28,766
(Provision) benefit for income taxes (749) 21,240
Income from continuing operations 105,135 50,006
Income (loss) from discontinued operations (net of tax
expense (benefit) of $5,596 in 2004 and ($12,494) in 2003) 19,698 (107,720)
Cumulative effect of change in accounting principle (58,342) –
Net income (loss) $ 66,491 $ (57,714)
Pro forma net income (loss) assuming the accounting change is applied retroactively $ 124,833 $ (60,840)
See accompanying notes.
NASD 2 004 ANNUAL FINANCIAL REPORT 25
CONSOLIDATED STATEMENTS OF CHANGES IN MEMBERS’ EQUITY
(DOLLARS IN THOUSANDS)
Equity Income (Loss) Total
Balance, January 1, 2003 $ 1,173,487 $ 1,069 $ 1,174,556
Net loss (57,714) (57,714)
Unrealized gain on available-for-sale investments, net of tax of $340, net of minority
interests of $340 – 34,068 34,068
Foreign currency translation, net of minority interests of $856 – 1,092 1,092
Minimum pension liability, net of tax of $191, net of minority interests of ($135) – 494 494
Comprehensive loss – – (22,060)
Increase in equity attributable to the minority interest in preferred stock dividends 3,781 – 3,781
Increase in equity attributable to the issuance of stock by NASDAQ and its
subsidiaries, net of minority interest of $684 791 – 791
Decrease in equity attributable to amortization of restricted stock awards by NASDAQ,
net of minority interest of $44 (154) – (154)
Balance, December 31, 2003 1,120,191 36,723 1,156,914
Net income 66,491 66,491
Unrealized gain on available-for-sale investments, net of tax of $599 net of minority
interests of $(409) – 34,689 34,689
Foreign currency translation, net of minority interests of $99 – 113 113
Minimum pension liability, net of tax of $293, net of minority interests of $(201) – (4,543) (4,543)
Comprehensive income – – 96,750
Increase in equity attributable to the minority interest in the loss on exchange and
accretion of NASDAQ preferred stock 2,191 – 2,191
Increase in equity attributable to the minority interest in preferred stock dividends and
distributions to NASD for the NASDAQ insurance agency 3,894 – 3,894
Increase in equity attributable to the issuance of stock by NASDAQ and its
subsidiaries, net of minority interest of $1,121 1,154 – 1,154
Increase in equity attributable to amortization of restricted stock awards by NASDAQ,
net of minority interest of $100 122 – 122
Balance, December 31, 2004 $ 1,194,043 $ 66,982 $ 1,261,025
See accompanying notes.
26 NASD 2004 ANNUAL FINANCIAL REPORT